The Pricing Problem in Health Care

Part of the problem we have with medical care—in the U.S. and elsewhere—is that it is incredibly difficult to price. That would be true in any circumstance, but it’s especially true given the lack of competition in the health care market. Reason contributor Arnold Kling has been thinking about this problem, and he has a great post looking at the pricing problem in the context of the Medicare payment system.

For both governments and private payers and providers, it’s very, very difficult to figure out how to value health care: Do you price based on input—the work (including education) that went into the service? Based on the value of the outcome to the individual? The value to society of the medical benefit? Medicare’s fee-for-service system ends up paying doctors based on quantity rather than quality. It’s not a true universal payer, like some other countries have set up, but the pay rates it uses exhibit a significant influence on the rest of the market. And even outside the influence of Medicare payment rates, private insurers don’t have a clear way to calculate rates. Kling argues that a system of competitive HMOs, each allowed to experiment with different provider groups and payment methods, might help solve the problem:

The socialist calculation problem is something that I worry about a great deal in the case of medical services. The insurance company is the socialist planner in this case. How does it know how much the consumer values a given medical service at the margin? How does it know the opportunity cost of the medical service?

I can see the problem being solved more easily in the context of a competitive market in HMO's. Each HMO guesses what combination of medical services at what price will maximize profits, in the same way that an automobile company guesses what combination of features at what price will maximize profits. No one solves the problem perfectly, but they keep groping for better answers.

In my mind, each HMO can produce its services using whatever combination of inputs it chooses. It can have physicians trained in medical schools, or it can train doctors internally. All forms of practice regulation and licensing have disappeared, and HMO's compete in part on the basis of reputation. Some medical services will be bungled, but that happens a lot in today's system, also.

The key here is allowing widespread experimentation. If you do that, some pricing and service models will fail. Some will succeed a little. A few might succeed a lot. But allowing experimentation in the health care sector, especially on the business side, which tends to control access and manage resource allocation, is tough in part because people are (understandably) afraid of failure.

In most markets, if a system fails, people move on. But in the health care market, failure—or even just the variety of outcomes that come from widespread experimentation—is far more fraught. We want everyone to have equal access and equal care, and that care should be the best possible care. Varied outcomes aren’t acceptable. And so we set up complex webs of regulations and licensing that attempt to guarantee that quality care is available to everyone. But the result is that we get stuck with business-side, resource-related problems—like, say, optimal pricing and service bundling—and don’t get to experiment with ways to fix them. So progress proceeds at a halting, bureaucratic pace, a project of careful, politically sensitive technocrats rather than entrepreneurs. We get state-run pilot programs. And payment system reforms. And formulas and bureaucracies charged with holding cost growth in check. Maybe some progress is made at the margins, but for the most part, the resource-allocation problems grow. And all the experts sit around wondering how to fix those problems, but afraid to take the one step that’s most likely to help, which is to let entrepreneurs innovate and experiment—and yes, to fail, sometimes—until they find some arrangement that works better.

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  • BakedPenguin||

    Wasn't this one of Mises' big themes? Absent a market, "correct" pricing for goods or (in this case) services is impossible.

  • 0x90||

    Quick: How many pacemakers will need to be built five years from now? What is your motivation to find the correct answer? What happens if you fail to predict correctly? To the high side? To the low? What should you do if a better solution is invented three years from now? What will you do with the older, now inferior units -- who gets them, and who gets the new ones?

    Price...is the least of your worries.

  • BakedPenguin||

    I've mentioned the book enough to be a broken record, but Hedrick Smith's The Russians chronicles this over and over again. While Smith was a NYT reporter, and a progressive, he was also honest about what he saw. He documents many cases of mis-allocation of resources on an incredible scale.

    While the book was written in the Brezhnev era USSR, it's still an interesting read.

  • 0x90||

    And it's not only the big stuff. I use Arm & Hammer baking soda & peroxide toothpaste. By now, I really can't imagine using anything else -- other typess are downright repulsive to me. I will go way out of my way to avoid using anything else; for travel, I buy the small tube of Crest or whatever, squeeze it all out into the trash, and replace it with mine.

    Not having my favorite toothpaste would not be the end of the world. That I do is a complete luxury. But the point is: how do you quantify preferences on this level? Because you have to, and however trivial, even something as trivial as toothpaste is an identifiable part of what makes life as good as it is.

  • Cyto||

    Well said! I suppose the problem with people who don't support liberty (whatever their political stripe) is that they truly believe that everyone should want to live exactly as they do.

    "Why would anyone want to live in a gay marriage?", asks the theocrat. "Why would anyone need a pickup truck with giant tires?", asks the progressive.

    "Why would anyone give a shit what someone else wants, eats, buys, fucks or owns?", asks the libertarian.

  • robc||

    Not a fair response for libertarians. Some of us do give a shit what others eat/buy/fuck. We just dont try to legislate it.

  • Rich||

    Well said, yourself! Good nutshell.

    How do you respond to this question?
    "Why wouldn't anyone give a shit what someone else wants, eats, buys, fucks or owns?", asks the person who knows everything is connected.

  • Ayn_Randian||

    There is connected, and there is connected.

    Causality connects everything, but only the brainless think that because this is so that we can throw out indivisible, discrete concepts and autonomony.

  • Nancy Pelosi||

    Are you serial?

  • Cyto||

    I can't answer that, because I really don't care what other people are doing. Lebron James makes 50 million a year? Good for him! But I don't know him, so it makes no difference to me. That hot chick from accounting? Unless she's gonna let me join in, I couldn't care less who she's sleeping with. Yes, I'm strange like that. I realize that I have no common ground for discussion with the person who thinks it really, really matters what "the situation" is doing with some chick in a hot tub in New Jersey.

    Therein lies the problem. I can't put my head in a place where I understand why it would be important to anyone else if I enjoy a little bondage with Tony from purchasing. And for the authoritarians in the world it is self-evident that my trist with Tony is every bit their concern. This applies on the small stage of office gossip, and on the large stage of national policy on gay marriage. There really is no common ground for discussion because the underlying axioms of our world view are fundamentally incompatible.

  • sr7||

    Learn even the slightest bit of Hayek before you overreach like that again. Price is the heart of the socialist calculation problem which those examples you give are only particular instances of the problem (the solution found millions of times per minute of each day in the free market).

    Quick: How many pineapples will the store need to buy five weeks from now? What is your motivation to find the correct answer? What happens if you fail to predict correctly? To the high side? To the low? What should you do if a better supplier offers their services three weeks from now? What will you do with the back log of orders of now over priced produce -- how do we unload the old stock during the phase in, and how do we introduce the new ones?

    The answers are the same in either case of pineapples or pace makers. Before you mention 'matter of life and death', food is a matter of life and death and much more immediately so for the vast majority of people. The market is so efficient at this endeavor that it makes this life and death matter an enjoyable experience to actually go the market and pick your produce. Many items are out of the practical price range of most people (especially if your market carries a good wine selection), however, everyone manages to find something to their liking and satisfaction. Whereas the quasi-market of health insurance and care never is one you look forward to being the customer.

  • ||

    If you need a liver transplant and you can't have it because it is too expensive, there is a very good chance you will die. Not so if you can't afford a nice bottle of wine or caviar or other expensive food.

  • The Grim Reaper||

    If you find that a liver transplant is too expensive, maybe you don't want to live badly enough.

  • ||

    But if I die that means I didn't find something to my liking as claimed in sr7 failed food analogy. But I think you are too stupid to understand my point.

  • ||

    Or maybe it's because the government made selling part of your liver illegal thereby vastly decreasing supply.

  • sr7||

    No you simply did not study my analogy to a proper degree to get its gist because it is not flawed or 'failed' in any manner whatsoever. It is indeed perfect. Nothing less than a beacon of light in a world sorely needing light, your attempt to show it up is pure vanity.

    For your argument against it to have merit, mortality is nothing more than a result of market failure.

    For your argument against it to have merit, that supermarket would have to only cater to the rich with caviar and expensive wines, but it does not do that. Only feudal societies and that modern variant of feudalism, socialism, services the interest of elites exclusively.

    For your argument against it to have merit, starvation would have to be a less immediate concern than sickness. That is very rarely the case. Liver disease takes years to form, starvation is only a matter of days, and without the free market you would have to depend on either highly unreliable subsistence farming, or the charity of elites. That may be desirable to you, but not to me.

    Let the market deal with the problems of health care and insurance as unbounded as it does in the other necessities of life then you will have an abundance of solutions to the problem you give. That is not faith, as faith is no more required in the working of the market than it is in the working of gravity.

    No, your argument is the failure and we know it to be a failure in practice through observing the charade that goes on in Cuba, England and Canada, and in the manipulation of our markets as well where people not only die from mortality, resource scarcity, or malpractice but with the added help of obstruction and malinvestment of central planners.

    You cannot wish away this additional burden by pointing to a problem you find in services in our quasi-free market. Due to the problem of socialist calculation, central planning and its third way variants do not have solution sets beyond throwing resources haphazardly down the drain faster than the rate of systemic collapse.

  • ||

    Oh, I see. The more important something is, the more restrictions we need to place on providing it.

    That always works out so well.

  • 0x90||

    I don't see where we disagree. I simply attempted to present the problem from the point of view of the planner; for him, the question of price does not exist.

  • sr7||

    Then my contention is not necessarily with you but with the planner.

  • sr7||

    It occurred to me that I should have clarified that while writing the draft of the above post, but I got caught up in giving shape to my argument, and my criticism was rather mild in the first place, so I never did get back around to doing that. My apologies.

  • ||

    That's economics 101. Only a functioning market can determine the market-clearing price of things. Without a market, some other considerations will determine prices, and supply will not match demand.

  • JoshINHB||

    The HMOs in this scheme are still a socialist break from a functioning market.

    How about people pay out of pocket for health care the way they do for everything else and have insurance to cover catastrophic (more than 30% of your yearly salary) events.

    Nah,
    Thats crazy.

  • ||

    That is exactly what the system is here where I live. Doctor visits are as low as $2. and specialists about $30. This is all FREE ENTERPRISE--not govt health care. Most medicines do NOT need prescriptions. I live in Veracruz MEXICO

  • Chod||

    BEGGAR THY NEIGHBOR RACE TO THE BOTTOM EXTERNALITIES FEAR BLURP!

  • Mr. FIFY||

    Best. Chad. Post. Ever.

    Even if it was a spoof.

  • Alan Kellogg||

    First question to answer is; how much does it cost the health care provider to provide health care?

  • robc||

    Why should that matter at all?

  • Alan Kellogg||

    Everything costs. Sometimes it costs a little, sometimes it costs a lot, but everything costs.

  • robc||

    Unless Im the provider, why do I care?

    The cost to the consumer is what the market will bear. Let the providers figure out how much or if they make a profit.

  • JohnD ||

    Are you serious? You can't determine the price to the consumer if you don't know the cost to the provider. Duh! Even a socialst should know that.

  • cynical||

    Are you serious? The value of it is what it's worth to you, which is unrelated to the cost of providing it. If a service is worth, at most, $100 to you, but it costs a provider $200, then the best solution for both of you is not to get the service. Otherwise, the price can be anywhere between $100 and $200 for it to be a positive sum transaction.

  • ||

    It'll cost what we Democrats say it costs!

  • Fatty Bolger||

    I don't think it would fly. Just think of the number of Lifetime movies this would spawn, with little Timmy dying of ass cancer because his Mom's evil insurance company wouldn't pay for him to go to a "real" doctor.

  • BakedPenguin||

    He's got cancer! In his ass!

  • ||

    Mmm.. oh yess.. the tears of unfathomable sadness.. so yummy.

  • sr7||

    They recently replayed that on WGN. It never gets old. The dick guzzling pony in the background scene. Priceless.

  • DDavis||

    Medicine is cheap, government control is expensive.

    My biggest health problems are all legal and regulatory, denying my access to treatments I want, and greatly inflating prices.

    Regulations and government market interventions can easily drive up costs for services and medications 1000%.

    For a particular medication, one can but a month's supply the "off the street price" is $180, the insurance negotiated price is $80, the best price I've found from a US pharmacy is $25, and I've been told a month's supply abroad can be had as low as $1.

    This isn't a market, it's legally enforced market price segmentation.

  • Dan Lavatan||

    If you eliminate the requirment that only licensed doctors can practice medicine, the cost of medical care will bascially drop to minimum wage. Everyone will ditch health plans as the annual premium cost exceeds "Catestrophic" health costs.

    Eventually even medicare will catch on to this, and everyone can be treated for less than amount of tax.

  • robc||

    Thats silly. It wont be anywhere near minimum wage. Plenty of unlicensed fields, like say IT, dont get anywhere near that low. Because skill has value.

  • cynical||

    Who the fuck would practice medicine at minimum wage? For that matter, who would go to a minimum wage, unlicensed high school dropout for medical care?

    Your body has a natural healing ability, so any medical care has to be measured against that baseline. It's definitely possible for medical care to be a net negative, especially for illnesses short of cancer or organ failure. If you hear, "Well, don't want to sound like a dick or nothin', but, ah... it says on your chart that you're fucked up. Ah, you talk like a fag, and your shit's all retarded.", immediately exit the medical facility and use OTC drugs and bed rest to self-medicate.

  • 0x90||

    "When you have inflexible demand and constrained supply - price will do crazy things."

    Furthermore, we should also expect to find price getting out of line whenever excessive elasticity is present in the chain, i.e. when demand becomes too disconnected from supply, such as is the case when subsidy (usually masquerading as so-called insurance) is widely substituted for direct purchase by the customer himself. The lack of competition which results can facilitate massive inefficiencies in the system.

    As just one concrete example, a friend of mine works at a machine shop which deals almost exclusively in the medical machining sector. Where standardization normally occurs for purposes of efficiency, in this environment it does not, simply because there exists by now virtually no motivation for doing so. The end result is that the work done in that shop consists mainly of one-off machining of titanium bonescrews and such, the specs of which, I was surprised to learn, are drawn up by individual doctors on an case-by-case basis. Naturally, these things can cost hundreds or thousands of dollars each, where in a more direct market, with its drives toward standardization and mass production, the price might easily be expected to fall with in the $10-20 range.

    My observation is that people seem apt to consider the medical devices industry as being inherently costly, but in many cases, the fact is that it is costly only because it has been (however unintentionally) designed to be so inefficient and wasteful.

  • 0x90||

    (sorry, please ignore, I accidentally replied to the wrong post)

  • ||

    For both governments and private payers and providers, it’s very, very difficult to figure out how to value health care:

    huh?

    Go to to store. look at how much band aids cost...then go look at how much some scotch tape and cotten balls cost....heu look the prices are comparable...the scotch tape and cotton ball option being a little less expensive.

    man that sure was hard to price that.

    What an idiotic notion.

  • ||

    Right, do that same exercise with a hip replacement. Should I go to the hardware department and pick up 2x4 and some nice long bolts?

    Obviously the price of items you can buy at Wal-Mart, is not even remotely the same as pricing a bypass, or repairing an aneurysm. The difficulty comes in the highly specialized nature of some health care products and services.

    The problem comes not really in the pricing itself, but in the expectation that everyone should have access to those specialized and often rare services. It's kinda like trying to figure out pricing for an Aston One 77, but keeping in mind that everyone of every financial status, might need one, and should be able to afford one if the circumstances dictate that need.

  • Cyto||

    More than that - the normal price curve is supply/demand. Under this regime, the price is whatever the market will bear. Well, if you need a heart transplant or you will die, the price you will pay is... well, whatever you have. So unless there is a surplus supply the market will not reach equilibrium.

    For things that are relatively common, say heart bypass operations, the supply will rise to meet demand at some reasonable price point. But what about the rare and unusual? If there are not enough cases available to make a return, the supply will never exist, or will exist at such low levels that only the super-wealthy can afford it.

    When you have inflexible demand and constrained supply - price will do crazy things.

  • 0x90||

    "When you have inflexible demand and constrained supply - price will do crazy things."

    Furthermore, we should also expect to find price getting out of line whenever excessive elasticity is present in the chain, i.e. when demand becomes too disconnected from supply, such as is the case when subsidy (usually masquerading as so-called insurance) is widely substituted for direct purchase by the customer himself. The lack of competition which results can facilitate massive inefficiencies in the system.

    As just one concrete example, a friend of mine works at a machine shop which deals almost exclusively in the medical machining sector. Where standardization normally occurs for purposes of efficiency, in this environment it does not, simply because there exists by now virtually no motivation for doing so. The end result is that the work done in that shop consists mainly of one-off machining of titanium bonescrews and such, the specs of which, I was surprised to learn, are drawn up by individual doctors on a case-by-case basis. Naturally, these things can cost hundreds or thousands of dollars each, where in a more direct market, with its drives toward standardization and mass production, the price might easily be expected to fall with in the $10-20 range.

    My observation is that people seem apt to consider the medical devices industry as being inherently costly, but in many cases, the fact is that it is costly only because it has been (however unintentionally) designed to be so inefficient and wasteful.

  • Neu Mejican||

    This seems to ignore the long history that got us to this point. We aren't starting from scratch. Widespread competition led to the current situation.

  • cynical||

    Competition of doctors to meet the needs of insurers who compete for the business of employers. Patients can fuck right off.

  • Jesus Christ||

    Neu, you are such a boring dick.

  • ||

    There is no single perfect price for anything.

    That is all.

  • ||

    No, it didn't. As this graph indicates: http://en.wikipedia.org/wiki/F.....SA_GDP.gif

    Health care costs began rising significantly when Medicare came into existence, which makes perfect sense. Medicare took away the pricing equilibrium normally established by supply/demand curves. "Sure, I'll get that expensive treatment/medicine/apparatus, Uncle Sam is picking up the tab."

    Like it or not, Health Care is made up of goods and services that follow market dictates just as any other good or service. Any central planning bullshit just makes sure that resources are NOT allocated where they are needed most.

    Medicare was only made possible by enough people buying into the "people dying in the streets" mantra that was just as dishonest as the "Saddam has WMD's" mantra. Fearmongering, pure and simple.

    Add to all of this, the confusion many people have with "Health Care" and "Health Insurance", which as has been pointed out many times, is for CATASTROPHIC, UNEXPECTED events, not teeth cleaning.

  • ||

    This should have been a reply to Neu Mexican.

  • ||

    Widespread competition led to the current situation.

    Ooh! Market Failure!

  • ||

    "We want everyone to have equal access and equal care"

    Few people actually want that, though some will settle for it.

    "and that care should be the best possible care."

    adds 0 information

    "Varied outcomes aren’t acceptable."

    Most people are OK with varied health care outcomes, I assure you.

    "And so we set up complex webs of regulations and licensing that attempt to guarantee that quality care is available to everyone."

    We have a hunger to systemitize. This drive leads us deep into error.

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